I’m a fan of Warren Buffett. While most people watch TV shows on Netflix for entertainment, I love reading through the archives of Berkshire’s annual letters! Yes, it’s that bad.
But if you’re reading this article, I think you might be a bit different too. Maybe you’re proud to be an investment geek like me!
After all, being a Buffett fan has its perks. For starters, I learned about the concept of an “economic moat.” This principle has earned Buffett’s investment company, Berkshire Hathaway, billions of dollars in profits. It has become a guiding principle for my own investments.
In this article, I’ll explain what an economic moat is and why it’s one of Buffett’s core investment principles. Unlike Buffett, however, I won’t be sharing how to use this principle to buy stocks. Instead, I’ll show how small investors like you and me can use real estate investments to build a profitable economic moat.
Let’s first discuss what an economic moat is.
What is an Economic Moat?
An economic moat protects a company’s profits from being eroded by competitors. It’s like a wide moat around a medieval castle. Companies with wide economic moats possess lasting competitive advantages. This means competitors have a hard time replicating it.
For example, one of Buffett’s investments is Coca-Cola. Globally, the strong Coca-Cola brand creates a competitive advantage. No other sugary drink maker has been able to replicate their success with customers.
Buffett has long used this principle to evaluate and purchase his best investments. The result? An investment of 1,000𝑖𝑛𝐵𝑒𝑟𝑘𝑠ℎ𝑖𝑟𝑒𝐻𝑎𝑡ℎ𝑎𝑤𝑎𝑦𝑖𝑛1964,𝑎𝑡19 per share, would be worth $11.6 million by early 2015!
But what does this have to do with you? Should you, like Buffett, seek out companies with wide economic moats? Even Buffett himself advises most investors to invest in a basket of index funds, rather than picking individual stocks.
I’ve found you need to apply this principle more broadly, not just to stocks or bonds. Economic moats have been most effective for me in the realm of real estate investing.
Applying Economic Moats More Easily Through Real Estate Investing
With real estate investing, you can leverage your knowledge and skills to earn more on your investments. For example, you could research every property for sale or rent within a small area. As a local expert, you could find properties priced below their full value.
And unlike stocks sold on an exchange with millions of competing buyers, you’re often negotiating directly with the seller or their agent. This gives you a chance to get a better return on price.
Not every piece of real estate automatically has an economic moat, however. In the next section, I’ll share five competitive advantages you can look for in real estate investing:
- Pricing power
- Barriers to entry
- Switching costs
- Low-cost advantage
- Trade secrets
Here are just a few ideas for real estate investing trade secrets that I’ve used or seen others use over the years:
- Marketing resources to find deals – Finding good deals is often the hardest part of real estate investing. However, if you can find and cultivate little-known or hard-to-access sources of deals, you can create a strong competitive advantage for yourself. You can also use various online tools to help you, such as free stock market APIs, etc.
- Processes and systems – Real estate investing has long been a local, informal business. If you can bring a level of professionalism and systemization to your small business, you’ll create a competitive advantage. The book “Emyth” was a big help to me in this regard.
- Relationships/networking – Relationships are always important, but for local real estate investing, they’re even more critical. Building solid relationships with vendors and other team members creates an economic moat for you. Stephen MR Covey’s “The Speed of Trust” showed me the tangible economic value of solid relationships.
- Customer service – While the real estate itself is often the focus, how you treat your customers can make you stand out from competitors. Be creative and find ways to make your service unique. Seth Godin’s great work “Purple Cow” can inspire you in this regard.
- Real estate tricks – You can leverage your creativity and knowledge to increase profits in real estate investing. For example, you might decide to install tile or other hard flooring in a rental house. It might cost 20% more now, but it can save you many times that cost over the decade of ownership. There are many other similar real estate tricks that can give you an edge.
I bet you can find more trade secrets to make yourself more competitive in real estate investing. That’s the beauty of having investments you can personally influence.
Become a Moat Builder
There’s a reason Warren Buffett has made billions of dollars. He follows steadfast principles when investing, like buying businesses with economic moats. He’s also very smart, surrounded by smart people, like his partner Charlie Munger.
As a fan of Buffett, I try to inspire you to emulate his success. But you don’t have to emulate him exactly (though you can always buy shares of Berkshire Hathaway). Instead, you can emulate his principles and apply them to real estate investing. This is an investment area that allows you to create and protect your own investment success.
I wish you well on your investment journey!